Monday, October 29, 2007

Economics Articles

Just got the latest edition of American Economic Review in the mail, and a few things caught my eye:

1. Michael Conlin, Ted O'Donoghue, and Timothy J. Vogelsang, Projection Bias in Catalog Orders. These guys are trying to measure projection bias -- i.e., the fact that people don't accurately predict what they will want in the future. Why not? Because they are too influenced by present conditions. The specific method of demonstrating projection bias here is to look at 12 million or so catalog orders from an unnamed company that sells "weather-related items"; the date of orders; the zip code of the buyer; and whether the item was returned. They found that when the date of the order was colder by 30 degrees Fahrenheit, the amount of returns rose by 3.95 percent -- indicating that when today happens to be cold, people overestimate how much they will want that huge furry coat in the future. (Still, it seems a small effect size, no?)

2. Electricity deregulation has had a bad name since the Enron/California crises of the early 2000s. One paper shows that during the transition from cost-of-service regulation to wholesale markets in electricity has led electricity plants to become more efficient -- but mostly for "investor-owned plants" rather than for "publicly owned plants." Specifically: "The results of our work indicate that the plant operators most affected by restructuring reduced labor and nonfuel expenses, holding output constant, by 3 to 5 percent relative to other investor-owned utility plants, and by 6 to 12 percent relative to government- and cooperatively owned plants that were largely insulated from restructuring incentives." Kira R. Fabrizio, Nancy L. Rose, and Catherine D. Wolfram, Do Markets Reduct Costs? Assessing the Impact of Regulatory Restructuring on US Electric Generation Efficiency.

3. Charles R. Plott and Kathryn Zeiler, Exchange Asymmetries Incorrectly Interpreted as Evidence of Endowment Effect Theory and Prospect Theory. The endowment effect is a fancy psychological term for "a bird in the hand is worth two in the bush," I think. It basically means that you tend to value the things you have more than things that you don't have -- even if they are otherwise pretty similar. One typical experiment is to give some people a mug and then ask if they want to trade for a candy bar; and give other people the candy bar and ask if they want to trade for a mug. Most people stick with what they have, whether that's the mug or the candy bar. But in this paper, the researchers were able to make the endowment effect go away by changing the procedures around. For a fuller explanation, see here.

The only question I have is, the researchers seem to have experimented a great deal with "Georgetown law students." But had these law students just learned about the endowment effect in one of their classes? (I learned of it in a first-year torts class myself.) Seems like that might affect the results of the experiments.

4. Winner's curse is the term for what happens when someone gets caught up in the frenzy of an auction, bids too high, and ends up paying more than the item is worth (thus regretting the bid). In Marco Casari, John C. Ham, and John H. Kagel, Selection Bias, Demographic Effects, and Ability Effects in Common Value Auction Experiments, the researchers did some repeated auctions (of what, they don't seem to say, unless I'm missing something) in an experimental setting. By repeating the auctions, they can see whether the subjects learn from past auctions not to bid too high.

Results:

(A) Students with low SAT or ACT scores are more susceptible to the winner's curse, even during the repeated auctions when they've had some experience already.

(B) "women are much more susceptible to the winner's curse as inexperienced bidders than men, although this difference disappears for experienced bidders," and "this finding of a gender effect is the more remarkable because it is obtained while controlling for obvious confounding factors such as ability and college major." (The authors squirm a bit trying to come up with an explanation. They finally end up speculating that women are initially less experienced at competitive situations, and therefore they start out being too aggressive in bidding, but then soon learn from the experience.)

(C) "Economics and business majors are much more susceptible to the winner's curse than other majors, and continue to do worse even as experienced bidders." (They conclude that this is because aggressive people tend to major in economics and business. Sounds plausible to me.)

1 Comments:

Winner's curse is the term for what happens when someone gets caught up in the frenzy of an auction, bids too high, and ends up paying more than the item is worth (thus regretting the bid).

That's related, but what I'd call "winner's curse" is simply the logical result of the fact that whoever wins an auction valued the object more than everyone else. Given any significant chance of error in evaluating the worth of the object, it becomes very likely that the winner won because he made a mistake and valued the object too much. This doesn't apply when the winner really has a good reason to have a higher value for the object than everyone else, but in cases where the bidders have roughly similar uses for the object, it does.

Some people overvalue, some people undervalue, and some are nearly right. The winner is likely to be from the first group. Note that this explanation works for cases both with and without "frenzy" and irrationality-- it works when the winner is merely mistaken (but calmly and rationally bids).